Description

Toyota Industries (TICO) is the oldest firm in the Toyota galaxy, from which the famous Toyota Motor company (TM) was spun-off in the 1930s. While lesser known than TM, TICO is a very attractive company:

- it is the worldwide leader in material handling solutions, a structurally growing business where the firm enjoys ~25% market share and strong competitive advantages (size advantage, large service network, leading production capabilities, etc.)

- it is the worldwide leader in auto AC compressors, also a growing business where TICO holds 40% market share and barriers to entry are growing

- it has a very large amount of cross-shareholdings, which added to net cash cover ~70% of current market cap (stakes are mostly in Toyota Motor and DENSO, firms from the Toyota group)

- it has several other legacy assets representing a smaller share of NAV, which should continue to develop slowly and are not part of our thesis (car assembly, engine manufacturing, electronic components manufacturing)

- the stock has ample liquidity

 
Sales split per geography is 30% sales in Japan, 30% in North America, the remaining 40% is split between Asia & ROW. The group has production facilities split between these different continents.

TICO is available today at ~6,5x look-through P/E, 0.7x P/B. Alternatively, applying earnings multiple of competitors KION and Jungheinrich to TICO’s material handling business covers 80% of the market cap. On top of this you get a large portfolio of shares and the growing AC compressor business for free.

I think this represents a discount to peers and intrinsic value, and this is due to several factors:
- cyclicality in the material-handling & auto businesses. I acknowledge cyclicality, however I believe the current price offers a strong margin-of-safety. The material handling business derives 40% of sales from maintenance and spare parts. TICO is also ideally positioned to benefit from EV growth worldwide as well and should be more resilient than the overall auto market.

- scant communication by the firm and coverage. The stock is covered on the sell-side by auto analysts, while more than 70% of EBITA comes from the material handling business. I believe analysts do not attribute enough credit to TICO’s position in material handling.

- change from J-GAAP to IFRS strongly reduced topline in the auto business, making growth appear lower than it really is.

- a wide discount is applied to cross-shareholdings by the sell-side and the buy-side (MUFG’s analyst applied a 50% discount in his note, w/o justification). I do not think this makes sense, particularly given the current context in Japan.

I - The material handling business

II - The auto components business

III - Details on capital allocation and M&A

I - The material handling business (64% sales, 76% EBITA, ~8% EBITA margin)

Forklifts (80% of the material handling segment, out of which 40% are spare parts & maintenance)

TICO is the largest manufacturer of forklifts worldwide, with about a 25% share in both sales and volumes through their brands Toyota, BT, L&F, Raymond and CESAB. They manufacture all classes of forklift (1 to 5) and sell them everywhere mostly through their own dealerships but also via distributors. Forklifts are used inside and outside the warehouse to move goods and pallets, whose number is estimated to grow around 2% p.a. over the next few years.

 The worldwide market represents 1.1M units per year and has grown at roughly a 4% CAGR since the GFC, mainly due to Asia and North America. This growth was enabled due to the industrialisation and development of logistics as well as the environmental norms, as most forklifts still use ICE.

The curve here makes some investors wonder about how long can this kind of growth continue. Senior people in the forklift business recognized the sector has seen some very good years, however, the need for forklift has been growing since the GFC due to the growth in global trade and the growth of e-commerce. The space required for 1$ of sales in e-commerce is 3x that of brick-and-mortar. This increase in distribution footprint is helping drive growth for forklift manufacturers and is expected to continue as EC keeps on growing:

Per geography, TICO has 50% market share in Japan (n°1 for over 50 years), 34% in the US (n°1 for over 15 years), 23% in Asia ex-China, 22% in Europe. TICO has only 1% share in China and 4% including Tailift which they acquired. The reason for their lower share in China is that the market is more geared towards entry-level products. TICO’s strength is recognized even by its competitors, as an Hyster-Yale person told me, talking about the US market: “Toyota is very strong, especially their Raymond brand".

The main competitors are KION (n°2 worldwide and n°1 in Europe) under the Linde, Fenwick, Still, Baoli and Egemin brands, Jungheinrich and Crown. The market is getting more concentrated, both in Japan and other continents with recent M&A moves, notably Logisnext (posted on VIC). Market shares are rather stable and growing slowly. TICO’s management see the potential for gaining share almost everywhere. The first 4 players (Toyota, KION, Jungheinrich, Logisnext) represent roughly â…” of worldwide volumes. Size in this business is critical for profitability, moreover you need a large network of technicians to visit clients, track & maintain the forklifts. At some periods during the year, TICO can visit clients several times a month. Despite the maintenance, the sector remains cyclicals: sales were down 18 and 33% in 2008 and 2008 with results breaking even at the EBIT level.

Logistics and warehouse automation (20% of the material handling segment, out of which 20% are services)

The presence of forklift manufacturers in the distribution centers of their clients led them to provide logistic solutions to their clients: conception of distribution centers, solutions for automatization (AGVs - automated vehicles, ASRS - automated storage and retrieval systems etc). This is done by developing internal solutions or acquisitions. TICO has 70% market share for ASRS in Japan but only 7% in the US where they are 4th, and 12% in Europe. There is a huge potential in this business, according to Citi over 90% of products stored in warehouses are still hand-picked (20-22 touches per item), so automation here looks very promising.

According to some senior executive from the sector:

“There's no way firms can handle the growth in e-commerce order with the logistic setups from 10 years ago, which explains the growth in the sector. The mobility automation solutions (robots/AGVs moving things) have the lowest value added compared to the manipulation and sorting automation solutions (picking or sorting orders / automatically, grabbing different items) because it's an easier engineering problem to solve. Daifuku & Toyota Industries are the only two firms able to handle all these tasks: mobility, picking, sorting, system integration. Other strong players worldwide like Intelligrated don't have the mobility automation. Kion doesn't have the sortation part, which is the highest added value again. With that in mind why should the implied valuation of Vanderlande be lower than the valuation of Kion ? If I'm Zulily, and I have to deploy 3 fulfillment centers in the next 24 months, I don't have time to be evaluating all the mobility companies to pick the best-in-breed, then looking at all the sortation technologies and say "yeah, I think I’ll pick this one", and looking at all the manipulation companies and say "yeah, I'll chose Winright". Instead, you just wanna say, "Here, 3 of them, you have 24 months". And that is why the order book of Daifuku grows the way it does. 80% of the warehouses in the US are still at "low levels" of automation”:

Over the last few years, we have seen several acquisitions in the space made by forklift manufacturers. KION acquired Dematic in 2016, and acquired substantial know-how due to this. In 2017, TICO acquired two leading companies in the space, Vanderlande and Bastian Solutions. Maybe due to the fact that these companies were private, I think not enough credit was given to TICO for these new assets, I’ll give a few notes to explain why Vanderlande is a great asset. The bottom line is that now, TICO is the 3rd global player in the space.

Vanderlande

Vanderlande is a leading provider of automation solutions for airport baggage handling as well as the parcel and logistics sectors in general. The firm has a strong know-how in end-to-end warehouse automation, as well as airport tech, and an example of their products can be seen on Youtube: https://www.youtube.com/watch?v=Gnk-ipOqjCI

They also have top notch clients: 12 out of the biggest EC sites in Europe, 17 out of the largest 25 airports in the world, etc. TICO didn’t disclose the financials separately, however Vanderlande publishes some numbers on its website. Here are a few put together, in M€:

The finance executives from Vanderlande appeared in the Dutch press last year, as they were candidate for the Best Finance team of the year: https://executivefinance.nl/2018/03/vanderlande-kandidaat-best-finance-team-vuurlinie/. In this interview, they explain that business is growing at a very rapid clip (orders +30%, expect organic growth for the next few years +20%). Converted to Yen, Vanderlande already represents 10% of TICO’s total revenues. Growing at 20% per year, this should guarantee the business 2% consolidated sales growth.

TICO bought the asset from a PE firm for 1,1x EV/Sales with mid-single digit EBIT margin. Soon enough it may look like a very cheap price.

Going forward, I expect stable to low single-digit growth for TICO’s materials handling segment, driven by Vanderlande and the logistics business while I assume the forklift business will remain flat.

II - The auto business (30% sales, 14% EBITA, ~4% EBITA margin)

Roughly half of this segment’s sales are made with TM. Sales are composed of:

- 60% are made on AC compressors for autos
- 16% on engine manufacturing for TM
- 13% on vehicle assembly for TM (Yaris, RAV4 etc.)
- 12% on electronic components parts

The 3 last businesses, representing 40% of sales of this segment, are rather mediocre, they generate low margins and require large capital employed. I expect them to keep on developing at a slow pace and remain profitable (recent negative profit there is due to model change for engines & vehicle assembly but profits should normalize from FY 2019). They are not part of my investment thesis.

The great business here is the AC compressor business for autos, where TICO enjoys a very strong number 1 position worldwide (roughly 45% share, 32+ M units !) with pricing power and growing barriers. AC compressors are an auto part with high and increasing technological content. The products must be made in clean environments. With the shift to HVs and EVs, technological constraints are increasing: because EVs are essentially silent, noise reduction and energy consumption must be very low, moreover EVs require different type of compressors which can function with their own engine. I think TICO’s edge here comes from the fact that they started doing R&D for these products more than 20 years ago, when TM released the world’s first mass-market HV, the Toyota Prius. The firm estimates their share in the EV compressor subsegment at roughly 70%. Today, TICO is number 1 by far, followed by Sanden (estimated 20% market share) and Hannon (estimated 15% market share).

 TICO’s compressors go on TM cars and also on major auto manufacturers worldwide (BMW, Mercedes…). TICO is not dealing with Tesla as they think volumes are too small for now. On top of having a large market share and promising growth ahead, this segment will benefit from increasing ASP, as EV AC compressors command roughly double the price of traditional compressors.

III - Details on capital allocation and M&A

M&A

A very quick point: I think the track record of TICO in terms of M&A in Japan is notable. They have managed to acquire, over the last 2 decades, several leading assets in the world (Raymond for the US market, Tailift, Vanderlande, Bastian Solutions). It is quite rate in Japan to see such success when it comes to foreign acquisitions. Right now, the firm is focusing on generating synergies and integrating their last 2 acquisitions, however, we can expect more value to come from M&A in the mid to long-term.

Cross-shareholdings

For historical reasons, TICO owns a very large share portfolio of stocks marked-to-market in its books. Roughly 70% comes from an 8.2% stake in TM, and 15% comes from an 8.9% stake in DENSO.

Capital allocation

They have a stable payout of ~30%, and did a share buyback when they divested some business unit in the past. They would reconsider it if they have a large gain, and are considering increasing the payout ratio slightly as well. Obviously many investors must not be satisfied with the large cross-shareholdings, however I see many reasons why this should change:

- the overall move towards better capital returns is well on its way in Japan, where payout and buybacks have been increasing year after year since Abe launched his reforms

- the dissolution of cross-shareholdings particularly, has been recommended by influent people such as Daisuke Hamaguchi, the chief investment officer at the Pension Fund Association, one of Japan's biggest pension funds. He advocated for the unwinding of cross-shareholdings, and said Japan should introduce tax-breaks as Germany did to unwind their cross-shareholdings. The government is considering this.

In the short-term, TICO’s stock evolves just as TMs stock, essentially meaning the market assigns very little value to the material handling business. I think sooner or later this value will be recognized.

Catalyst

- Better valuation of the material handling and logistics business by the market

- Unwinding of cross-shareholdings

- Better capital returns